Basel II Pillar 3

UBS publishes Basel II Pillar 3 disclosures on a semi-annual basis. Year-end disclosures are contained within this report. Disclosure elements not covered in the "Risk management and control" and "Treasury management" sections are shown below.

Introduction

On 1 January 2008, UBS adopted the revised capital framework of the Basel Committee on Banking Supervision - Basel II - which introduced new and amended capital requirements for the different risk types and revised the calculation of eligible capital.

The aim of Basel II Pillar 3 is to encourage market discipline by allowing market participants to assess key pieces of information regarding the capital adequacy of banks via a set of disclosure requirements.

This section presents UBS's Basel II Pillar 3 disclosures as of 31 December 2008 and consists mainly of quantitative disclosures complemented with explanatory text where needed.

Qualitative disclosures related to the bank's risk management and control, definitions and risk exposures as well as capital management can be found in the "Risk management and control" and "Treasury management" sections of this report

General description of risk exposure measures and capital requirements

Measures of risk exposure may differ depending on the purpose for which exposures are calculated: financial -accounting under International Financial Reporting Standards (IFRS) determination of regulatory capital, or UBS's internal management. UBS's Basel II Pillar 3 disclosures are based on the measures of risk exposure that are used to calculate the regulatory capital that is required to underpin those risks.

Under the advanced Internal Ratings Based (IRB) approach applied by UBS for the majority of its businesses, credit risk weights are determined by reference to internal counterparty ratings and loss-given default estimates. UBS uses internal models, approved by FINMA, to measure the credit risk exposures to third parties on over-the-counter derivatives and repurchase-style (repo-style) transactions. For a subset of its credit portfolio, UBS applies the standardized approach (SA-BIS), based on external ratings.

Securitization exposures in the banking book are treated under the Ratings Based Approach (RBA), applying risk-weights based on external ratings. Non-counterparty related assets such as UBS premises, other properties and equipment require capital underpinning according to prescribed regulatory risk weights.

For market risk positions, UBS derives its regulatory capital requirement from its internal Value-at-Risk (VaR) model, which is approved by FINMA.

UBS has developed a model to quantify operational risk, which meets the regulatory capital standard under the Basel II Advanced Measurement Approach (AMA).

Basel II requires deduction of some positions from eligible capital, most notably goodwill, intangible assets (excluding software), net long positions in non-consolidated participations in financial institutions and certain positions in securitization exposures.

The naming conventions for the "Exposure segments" used in the following tables are based on the BIS rules and differ from those under Swiss and EU regulations. "Sovereigns" under the BIS naming convention equate to "Central governments and central banks" as used under the Swiss and EU regulations. Similarly "Banks" equate to "Institutions" and "Residential mortgages" equate to "Claims secured on residential real estate".

Additional capital management disclosures

Although UBS determines published risk-weighted assets (RWA) according to the Basel II Capital Accord (BIS guidelines), the calculation of UBS's regulatory capital requirement is based on the regulations of FINMA, leading to higher RWA.

Generally, the scope of consolidation for purposes of calculating these regulatory capital requirements follows the IFRS consolidation rules for subsidiaries directly or indirectly controlled by UBS AG which are active in the banking and finance business, but excludes subsidiaries in other sectors. The significant operating subsidiary companies in the Group consolidated for IFRS purposes are listed in "Note 34 Significant subsidiaries and associates" in the financial statements of this report. More specifically, the main differences in the basis of consolidation for IFRS and regulatory capital purposes relate to the following entity types and apply regardless of UBS's level of control:

- Real estate and commercial companies as well as collective investment schemes are not consolidated for regulatory capital purposes but are risk-weighted.

- Insurance companies are not consolidated for regulatory capital purposes but are deducted from capital.

- Securitization vehicles are not consolidated for regulatory capital purposes but are treated under the securitization framework.

- Joint ventures that are controlled by two ventures are fully consolidated for regulatory capital purposes, whereas they are valued under equity method accounting for IFRS.

The "Detailed segmentation of required capital" table above provides a granular breakdown of UBS's capital requirements.

Credit risk

UBS's Pillar 3 disclosure presents the details on the parameters and input data used in its regulatory capital calculation. Although the parameters applied under the advanced IRB approach are generally determined using the same methodologies, data and systems as UBS uses for internal risk quantification, there are nevertheless several differences due to regulatory floors, multipliers, eligibility criteria and exposure definitions that cause the figures presented in this section to deviate from the information disclosed within the "Risk management and control" section of this report. The regulatory capital calculation of credit risk exposure also differs from that required under IFRS.

The Probability of Default (PD) and Loss Given Default (LGD) estimates applied in the regulatory capital calculation are the same as those used for internal risk quantification, with the regulatory prescribed exceptions of a PD floor of 0.03% for non-sovereign exposures, an LGD floor of 10% for residential mortgages and a downturn LGD addressing a potential worsening of the economic cycle. However, because the regulatory exposure definitions are different from the internally applied exposure definitions for traded products, the rating and LGD distributions presented in this section deviate from the information presented in the "Risk management and control" section of this report.

For banking products, there are no differences in the Exposure at Default (EAD) calculation between the regulatory and the internal management views. However, due to some differences in the scope of consolidation and segmentation, the regulatory exposure reported for Pillar 3 purposes differs from the internal management view of credit exposures which is reported in the "Risk management and control" section of this report.

The regulatory exposure for traded products is predominantly calculated on the same systems using the same models that are used for internal risk quantification. However, whereas in the "Risk management and control" section of this report the maximum likely exposure is shown, this section reports the respective regulatory exposure measures. For securities financing exposures, this is the Close-Out VaR measure as defined in paragraphs 178 to 181 of the Basel II framework. For derivative exposures, UBS has received approval from FINMA to apply the Effective Expected Positive Exposure (EPE) as defined in Annex 4 to the Basel II framework. For a minor part of the portfolio, UBS also applies the Comprehensive Approach or the Current Exposure Method.

In the tables in this section, the regulatory net credit exposure shows the Basel II EAD after all collateral, netting and other eligible risk mitigants have been applied as specified by the relevant regulation. Certain Pillar 3 tables also require a regulatory gross credit exposure view, which differs for banking products in that cash balances in margin accounts are not offset with the corresponding traded products exposures. This section also presents information on impaired and defaulted assets in a segmentation which is consistent with the regulatory capital calculation.

The table "Derivation of risk-weighted assets" on the previous page shows the derivation of risk-weighted assets from the regulatory gross credit exposure.

The "Regulatory gross credit exposure by geographical region" table on the previous page provides a breakdown of UBS's portfolio by major types of credit exposure according to classes of financial instruments and also by geographical regions. The latter distribution is based on the legal domicile of the customer.

The table "Regulatory gross credit exposure by counterparty type" on the previous page provides a breakdown of UBS's portfolio by major types of credit exposure according to classes of financial instruments and also by counterparty type. The classification of counterparty type applied here is also used for the grouping of the balance sheet. Refer to the financial statements in this report for more information. The counterparty type is different from the Basel II defined exposure segments used in certain other tables in this section.

The "Regulatory gross credit exposure by residual contractual maturity" table on the next page provides a breakdown of UBS's portfolio by major types of credit exposure according to classes of financial instruments and also by maturity. The latter distribution is based on the residual contractual tenor.

The "Regulatory gross credit exposure covered by guarantees and credit derivatives" table on the next page -provides a breakdown of collateral information, showing -exposures covered by guarantees and those covered by credit derivatives, according to Basel II defined exposure segments. These are defined as follows:

- Corporates: consists of all exposures that do not fit into any of the other exposure segments below. Mostly, it -includes private commercial entities such as corporations, partnerships or proprietorships, insurance companies, funds, exchanges and clearing houses.

- Sovereigns ("Central governments and central banks" under Swiss and EU regulations): consists of exposures relating to sovereign states and their central banks, the Bank for International Settlement (BIS), the International Monetary Fund (IMF), the European Union including the European Central Bank and eligible multilateral development banks (MDB).

- Banks ("Institutions" under Swiss and EU regulations): consists of exposures towards banks, i.e. legal entities holding a banking license. It also includes those securities firms that are subject to supervisory and regulatory arrangements comparable to those applied to banks according to the Basel II Revised Framework, including, in particular, risk-based capital requirements. Basel II also defines this regulatory exposure segment such that it contains exposures to public sector entities with tax raising power or whose liabilities are fully guaranteed by a public entity.

- Residential mortgages ("Claims secured on residential real estate" under Swiss and EU regulations): consists of residential mortgages, regardless of exposure size, if the obligor owns and occupies or rents out the mortgaged property.

- Other retail: consists of exposures to small businesses, private clients and other retail customers without mortgage financing. Notably, this includes the lombard loan portfolio.

The collateral amounts in the table reflect the values used for determining regulatory capital. However, UBS has engaged in a substantial credit hedging program to reduce concentrated exposure to individual names or sectors or in specific portfolios, which is not fully reflected in the regulatory numbers in this section.

The "Derivation of regulatory net credit exposure" table on the next page provides a derivation of the regulatory net credit exposure from the regulatory gross credit exposure according to the advanced IRB approach and the Standardized approach. The table also provides a breakdown according to Basel II defined exposure segments.

Advanced IRB approach

The upper part of the table "Advanced internal ratings-based approach: regulatory net credit exposure by UBS-internal rating" below provides a breakdown of the regulatory net credit exposure of UBS's credit portfolio using the advanced IRB -approach according to UBS-internal rating classes.

The middle part of the table "Advanced IRB approach: exposure-weighted average loss given default by UBS-internal rating" provides a breakdown of the net exposure-weighted average loss given default for UBS's credit portfolio exposures calculated using the advanced IRB approach, -according to UBS-internal rating classes.

The lower part of the table "Advanced IRB approach: exposure-weighted average risk-weight by UBS-internal rating" provides a breakdown of the net exposure-weighted average risk-weight for UBS's credit portfolio exposures calculated using the advanced IRB approach according to UBS-internal rating classes.

Standardized approach

The standardized approach is generally applied where it is not possible - usually for technical reasons - to use the advanced IRB approach and / or where an exemption from the advanced IRB has been granted by FINMA. The standardized approach requires banks to use risk assessments prepared by External Credit Assessment Institutions (ECAI) or Export Credit Agencies to determine the risk weightings applied to rated counterparties.

ECAI risk assessments are used by UBS to determine the risk weightings for the following classes of exposure:

- Central governments and central banks;

- Regional governments and local authorities;

- Multilateral development banks;

- Institutions; and

- Corporates.

UBS has selected three FINMA-recognized external credit assessment institutions for this purpose - Moody's Investors Service, Standard and Poor's Ratings Group and Fitch Group. The mapping of external ratings to the standardized approach risk weights is determined by FINMA and published on its website.

The "Regulatory gross and net credit exposure by risk weight under the standardized approach" table below provides a breakdown of the regulatory gross and net credit exposure by risk-weight for UBS's credit portfolio exposures treated under the standardized approach, according to Basel II defined exposure segments.

The "Eligible financial collateral recognized under standardized approach" table below provides a breakdown of the financial collateral, which is eligible for recognition in the regulatory capital calculation under the standardized approach, according to Basel II defined exposure segments.

Impairment, default and credit loss

The "Impaired assets by geographical region" table below provides a breakdown of credit exposures -arising from impaired assets and allowances / provisions by geographical region, based on the legal domicile of the customer. Impaired asset exposures include loans, off-balance sheet claims, securities financing transactions and derivative contracts.

The "Impaired assets by exposure segment" table on the next page shows a breakdown of credit exposures arising from impaired assets and allowances / provisions according to Basel II defined exposure segments. Impaired asset exposures include loans, off-balance sheet claims, securities financing transactions, and derivative contracts.

The "Changes in allowances, provisions and specific -credit valuation adjustments" table on the next page provides a breakdown of movements in the specific and collective allowances and provisions for impaired assets, including changes in the credit valuation allowance for derivatives.

The "Total credit loss at year-end 2008" table on the next page provides a breakdown of the credit loss amount charged against UBS's income statement in 2008 according to Basel II defined exposure segments of the advanced IRB approach.

Other credit risk tables

The "Credit exposure of derivatives instruments" table below provides an overview of UBS's credit exposures arising from derivatives. Exposures are provided based on the balance sheet carrying values of derivatives as well as regulatory net credit exposures. The net balance sheet credit exposure differs from the regulatory net credit exposures because of differences in valuation methods and the netting and collateral deductions used for accounting and regulatory capital purposes. Specifically, net current credit exposure is derived from gross positive replacement values, whereas regulatory net credit exposures is calculated using UBS internal credit valuation models.

The "Credit derivatives" table below provides an overview of UBS's credit derivative portfolio by product group using notional values. The table also provides a breakdown of credit derivative positions used to risk manage UBS's own credit portfolio (banking book for regulatory purposes) and those arising through intermediation activities (trading book for regulatory capital purposes).

Investment positions

The "Equities disclosure for banking book positions" table below provides an overview of UBS equity investments held in the banking book for regulatory capital purposes. The calculation of equity investment exposure for financial accounting under IFRS differs from that required for regulatory capital purposes. The table illustrates these two measures of exposure as well as the key differences between them.

The IFRS view differs from the regulatory capital view primarily due to: (i) differences in the basis of valuation, that is IFRS is based on "fair value accounting" whereas the "lower of cost or market value" (LOCOM) and "cost less impairment" is used for regulatory capital purposes; (ii) positions that may be treated under a different framework for regulatory capital purposes, for example tradable assets treated under Market Risk VaR; and (iii) differences in the scope of consolidation for IFRS, for example, special purpose entities consolidated for IFRS but not for regulatory capital purposes.

Also disclosed in the table are realized and unrealized gains and losses. There were no unrealized gains and losses that were not recognized either on the balance sheet or in the statement of income relating to "available for sale" investments designated at fair value. In addition there was no significant disparity between the share prices of investment positions held in publicly quoted entities and their fair value.

Securitization

Sources and control of risks resulting from securitization structures

Historically UBS was involved in many aspects of the origination of securitization structures. This ranged from warehousing assets as principal and for clients, the creation of securitization vehicles, as well as underwriting, market-making and managing securitized assets. UBS retained securitization exposures in the form of senior or subordinated tranches (including first loss positions) and interest only strips. UBS also purchased third-party securitization positions as part of its trading activities. UBS has not, however, provided any material liquidity facilities for securitization structures and has not acted as a sponsor of securitization schemes to purchase exposures from third-party entities.

UBS significantly reduced its exposures to securitization related assets in 2008 through a combination of asset sales and writedowns. As announced in October 2008 and February 2009, UBS is repositioning its Investment Bank to focus primarily on client activities. As part of this repositioning, the Investment Bank will largely exit its real estate and securitization activities. Refer to the "Investment Bank" section of this report for more information. Remaining positions at 31 December 2008 that are treated under the securitization framework for regulatory capital purposes include the global reference-linked note programs. These positions are subject to appropriate portfolio limits and risk controls.

During 2008, UBS acquired student loan auction rate securities (ARS) from its provision of liquidity to these markets by submitting bids to ARS auctions and from its commitment to restore liquidity to client holdings of ARS. Refer to the "Exposure to auction rate securities" sidebar in the "Risk management and control" section of this report for more information. For regulatory capital purposes, exposures from these positions are also treated as securitizations and are subject to appropriate portfolio limits and risk -controls.

Regulatory treatment of securitization

UBS generally treated exposures from securitization positions under market risk regulatory capital and any remaining securitization exposures that are still subject to this treatment do not form part of this disclosure. Exposures from the global reference-linked note programs and certain originated traditional securitizations were treated under the securitization approach for regulatory capital and are therefore included in this disclosure.

In first quarter 2008 certain securitization exposures relating to illiquid US real estate positions (specifically super senior US RMBS CDOs, sub prime and Alt A RMBS, and related hedges) were excluded from internal management and regulatory VaR and were therefore no longer treated under market risk regulatory capital. Refer to "VaR developments in 2008" in the "Risk management and control" section of this report for more information. These positions are treated under the standardized approach as agreed with FINMA and are therefore not included in this disclosure.

UBS generally applies the Ratings Based Approach to securitization exposures in the banking book using Moody's, Standard & Poor's and Fitch's Ratings for all securitization exposures. Unrated tranches for which no rating can be inferred are deducted from eligible capital. Under the Ratings Based Approach the amount of capital is capped at the capital requirement that would be assessed against the underlying assets had they not been securitized. On 31 December 2008 such exposures mainly included the student loan ARS positions (including purchase commitments) and the global reference-linked note programs.

Interest rate or foreign currency derivatives with securitization vehicles are treated under the advanced Internal Ratings Based approach.

Accounting Policies

For IFRS purposes, UBS treats originated securitized exposures as sales, i.e. they are derecognized from UBS's balance sheet provided that specific derecognition criteria are met and UBS does not consolidate the transferee (as described in "Note 1 Summary of significant accounting policies" in the financial statements of this report). A gain or loss on sale is recognized when the exposures are derecognized. Derivatives used for synthetic securitizations are accounted for in line with the abovementioned note.

Securitization positions that are classified as trading assets for IFRS purposes are valued at fair value as described in "Note 27 Fair value of financial instruments" in the financial statements of this report. Securitization positions that have been redesignated from trading assets to loans and receivables are valued at cost less impairment as described in "Note 1 Summary of significant accounting policies" in the financial statements of this report.

Good practice guidelines

On 18 December 2008 the European Banking Federation, the London Investment Banking Association, the European Savings Banks Group and the European Association of Public Banks and Funding Agencies published the "Industry good practice guidelines on Pillar 3 disclosure requirement for securitization". UBS is in compliance with material aspects of these guidelines.

Securitization activity during 2008

The first table below shows exposures that have been securitized by UBS via a traditional securitization during the year. It also shows any gains or losses recognized on sales into these traditional securitization structures for regulatory capital purposes. The exposure values disclosed are based on the transaction date and were accounted for at fair value pre-securitization (the resulting gain or loss is not significant). UBS retained securitization positions for all traditional securitization made in 2008. No synthetic securitizations occurred during 2008.

Total outstanding exposures securitized - synthetic securitizations

The second table below provides a breakdown of the inventory of the total outstanding exposures that have been securitized by UBS via synthetic securitizations prior to 2008 as part of its global reference linked note program. Historically, UBS retained securitization positions from its synthetic securitizations. The exposure values disclosed are calculated on the basis of their regulatory exposure value. Due to the transfer of assets to the SNB fund, however, UBS no longer holds securitization positions of all synthetic securitizations.

Amount of impaired / past due assets securitized - synthetic securitizations

The third table below provides a breakdown of the inventory of outstanding impaired or past due exposures that have been securitized by UBS via a synthetic securitization. The exposure values are based on the amounts referenced in the transaction and are included into the below disclosure once a credit event has occurred.

Losses recognized on originated transactions in 2008

The table below provides a breakdown of losses recognized by UBS on securitization tranches purchased or retained that result from a securitization originated by UBS, after taking into account the offsetting effects of any credit protection that is an eligible risk mitigation instrument for the retained or repurchased tranche. UBS partially reports such exposures on a fair value and partially on a cost less impairment basis. These losses mainly include losses related to the global reference-linked note program.

Securitization exposures retained or purchased

The table below provides a breakdown of securitization exposures purchased or retained by UBS, irrespective of its role in the securitization transaction. The exposure values disclosed are calculated on the basis of their regulatory exposure value.

Capital charge for securitization exposures retained or purchased

The table below provides a breakdown of securitization exposures purchased or retained by UBS, irrespective of its role in the securitization transaction as well as a breakdown of the related capital requirement.